Assessing the Impact of Credit Derivative Seller Disclosure

The 2008 U.S. financial crisis raised questions about the quality of derivative disclosure by banks. I investigate banks that sell credit derivatives and the impact of recent disclosure mandated for these banks. Using measures of information asymmetry, I find banks that sell credit derivatives are more opaque than those that do not. Furthermore, difference-in-difference tests indicate improved bank transparency following mandatory increases in credit derivative seller disclosure. Because credit derivative sellers act as market makers in the credit default swap (CDS) market, I extend my analysis to investigate the effect of disclosure on liquidity in the CDS market. Results from these tests are consistent with a decrease in CDS market liquidity following mandatory disclosure. This finding comports with recent analytical studies of markets where liquidity providers have an information advantage. In these markets, information asymmetry spurs competition among market makers which, in turn, drives market liquidity. Taken together, my results suggest that mandated disclosure for sellers of credit derivatives provided transparency for investors in the equity market at the cost of decreased liquidity in the CDS market